In the early 2000’s, John Bogle, founder of Vanguard, tried to organize index-fund managers and coordinate their shareholder votes to greater impact the companies they owned. At the time, index funds were not very popular, which led other firms to scoff at the idea and recommend that they submit to “the invisible hand of the marketplace.”

Since then, things have certainly changed—as Bogle recently said, “We are the invisible hand of the marketplace.” Index-tracking funds now own 11.6% of the S&P 500, which is considerably more than the 4.6% from ten years prior. More and more individuals are choosing to take advantage of the low fees and passive approach that index funds embody, so money is flowing from active managers to passive funds.

As a result, we are experiencing new market dynamics. For example, some people worry that the market will not be as efficient, meaning that stocks will be allowed to trade beyond or below their true fair market value for an extended period of time. Currently, we have an abundance of active managers who are always looking for price discrepancies to make a dollar, but a shift could slow down that process.

Right now, we are seeing a power shift on the boards of companies owned by large funds. Active managers who control billions of dollars for pensions and other institutions are typically activist investors, meaning they have large enough positions to get a seat on the company’s board and influence decisions about the company—firing management, corporate restructure, business strategy, etc.

Conversely, their passive counterparts who also manage billions for a growing number of entities are not nearly so bold. Their power is increasing as they control a greater and greater number of shares. However, these managers, like their investors, are long-term holders who believe operational decisions should mostly be left to management.

Now, you can view this shift in one of two ways: Daniel O’Keefe of Artisan Partners Ltd. Says, “The tyranny of passivity is you have large pools of money that are unengaged in their investments, a far greater risk than the tyranny of activism.” Basically, who will keep management accountable if stockholders are not keeping diligent watch?

But the opposing view would be that companies can finally shift their focus toward long-term goals and long-term growth. Currently, activist investors pressure management to perform better each quarter to protect the stock’s price. But that pressure forces management into the tunnel vision of short-term goals that is often to the detriment of long-term growth. Without that quarterly pressure, management could focus on the company instead of the just the company’s stock.

We really don’t know how this new dynamic will unfold. But my guess is that American ingenuity will continue, markets will adjust, and capitalism will continue to prevail. But only time will tell.

Josh Norris is an Investment Advisory Representative of LeFleur Financial. Josh can be reached at josh@LeFleurFinancial.com.

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